Behind Roche's Pharmaceutical Shake Up

| About: Roche Holding (RHHBY)

Roche's (OTCQX:RHHBY) hostile $5.7 billion bid for genetic diagnostic company Illumina (NASDAQ:ILMN) has opened a pandora's box of genetic information. The pharmaceutical giant appears to be aligning itself to become a one-stop-shop for pharmaceutical success, avoiding the outsourcing step of diagnostics. Roche acknowledged it foresees the $1 billion diagnostic field doubling by 2015, so the revenue stream benefits make sense. However, such an intense play raises some questions about Roche's full intentions. Is Roche looking to monopolize gene patenting? Will it possibly take sequencing technology to the consumer market? Or worse, is Big Pharma becoming Big Brother?

Who Benefits from Genetic Diagnostics?

Genetic diagnostic companies have languished somewhat between grant approved academia and the theoretical market of direct to consumer (DTC) genetic testing. Genetic testing, in theory, opens the world of knowledge to the general public from questions of pure narcissistic curiosity to dire health concerns. DTC genetic tests will face FDA regulatory hurdles in the United States and have yet to catch market fire as might have been envisioned by 2012. Life Technologies Corp. (NASDAQ:LIFE) announcement of the 24 hour, $1000 genome kicked off 2012 with a diagnostic bang, trumping Illumina's recent advances, though it left many wondering what was next in the field.

With Roche's bold step, a quick eye cut to other big pharmaceuticals for their move. Competitors like Eli Lilly (NYSE:LLY), Sanofi (NYSE:SNY), Novartis (NYSE:NVS) seem content to sit for now and not counterbid. Competitors were quick to question Roche's moves when sequencing a gene can be outsourced and drug specific. With rapidly changing technology, pioneers of sequencing like J. Craig Venter have been "puzzled" by the move. Speculation even surfaced that Roche may be playing the long term bet that gene sequencing technology could be the next publicly marketed tool and will come with a Roche label.

What's not questionable is the growing necessity of diagnostics in the drug industry. Biogen Idec's (NASDAQ:BIIB) recent win with its MS drug Tysabri and the accompanying genetic screening test for associated side effects highlights this. What was once a drug with questionable, potentially fatal side effects for an unknowable segment of the population is now a drug that can be safely prescribed to more individuals after assurance from a test marketed by Quest Diagnostics (NYSE:DGX). Pfizer's (NYSE:PFE) drug for lung cancer, crizotinib, was approved earlier in 2011 in concert with the Abbott Lab (NYSE:ABT) diagnostic test to determine if a patient has the gene mutation the drug targets. In the future it might be rare for a drug to be approved without an accompanying diagnostic and perhaps Roche wants to do it all in-house.

An even more ambitious motivation for ILMN takeover exists. With many drugs coming off patent in 2012, Roche may be looking to pioneer a new avenue while rebuilding their patent pipeline. Getting a bigger toe hold on gene sequencing and diagnostics would be a pivotal role in bringing the theory of gene therapy to reality.

The Gene Patent Pandora

Greater diagnostic capabilities mean greater gene patenting potential as well. Companies like Myriad, Inc. (NASDAQ:MYGN), which owns the patent for BRCA1 and BRCA2 breast cancer associated genes, receive royalties on the BRACAnalysis test which cost $3,300 each and net over $300 million in revenues annually. Myriad announced in mid-January that it received a new patent for gene RAD51C, a more widespread variant associated with breast and ovarian cancer. Sadly, many Americans could not tell you the name of many genes, but MYGN has made BRCA more familiar for better or worse.

In some respect, there may be a quieter race to acquire gene patents. To date, an estimated 20% of the human genome has been patented, though the exact amount is debatable. The Human Genome Project makes the human genome and its approximate 25,000 genes public knowledge but who "owns" parts of the genome is another story. As of January 19, 2012, the US has issued 61,494 gene patents according to the Kennedy Institute of Ethics DNA Patent Database. The number of applications spiked to over 13,000 in 2003, the year of the Human Genome Project's completion. The number of patents, which dipped in the years following, has rose significantly again with 2011 ranking the highest in 10 years. While some erroneously think a patented gene makes it off limits for anyone other than the patent holder to research it, it does mean the patent holder receives royalties and licensing control over its genetic testing, a very lucrative and controversial field. In the realm of genetic knowledge however, with great power comes great responsibility and ethical questions.

In March 2010, US District Judge Robert W. Sweet of Manhattan ruled that gene patents were invalid as genes are a naturally occurring resource. The case in question centered around Myriad's gene patents on BRCA1 and BRCA2. The suit was brought by the ACLU and the Public Patent Foundation ((PUBPAT)). The initial ruling spoke volumes about the US court's stances on the direction of pharmacological genetics, if only for a short time. In July 2011, the Court of Appeals for the Federal Circuit ruled that isolated DNA is markedly different than DNA that naturally appears in the genome of an individual since an identified gene has been isolated and sequenced. This victory saw Myriad's stock spike then as it has once again now with genomic diagnostics in the news. The ACLU has since vowed to bring the issue to the Supreme Court, promising more volatility.

Early Bird Gets the Worm?

The benefit of genetic information comes only with the power to utilize it. Roche seems to have recognized the power of such information. Likely the answer the the "why" behind Roche's bid is a bit of all of the above. Perhaps its is akin to the big man on campus asking the diamond in the rough girl to Prom before she knows what she's worth. With talk of poison pills and speculation on counterbids, maybe Illumina has already caught a glimpse in the mirror and seen its potential and is waiting for a better offer. Perhaps it is as perplexed as Roche's competitors. LIFE and Affimetrix, Inc. (NASDAQ:AFFX) have been named as other targets for potential acquisition should this move catch fire in the industry, though many are taking a wait and see approach to Roche's surprising move. What is the worm this early bird is really after?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.